U.S. workers need more money than ever before to retire comfortably, but reports have shown that they are struggling to save money.
Some hope a state-mandated retirement plan will help bridge the gap.
The crisis in retirement planning
Studies consistently show that employees are more likely to save when given access to a retirement plan at work. Further, research indicates that whether an employer provides retirement benefits plays a major role in job candidates’ decision to accept a position.
However, it’s been reported that only 4 in 10 employers with less than 100 workers offer retirement benefits. This coverage gap is a significant economic concern for states across the nation. Consequently, a growing number of states are implementing their own retirement plan.
What are state-mandated retirement plans?
As the name suggests, a state-mandated retirement plan is a retirement savings program sponsored by the state. These programs tend to target private-sector employees in small and midsize businesses and low-to-moderate income earners.
Note: They should not be confused with state retirement systems for public sector employees.
Most state-mandated retirement plans are structured as Roth individual retirement accounts (IRAs).
What is a Roth IRA?
There are 2 main types of IRAs:
With a traditional IRA, contributions are eligible for a tax deduction the year in which they are made. So, if the individual makes contributions in 2020, they can exclude the amount from their taxable income for 2020. However, the contributions are taxed upon withdrawal.
With a Roth IRA, contributions are made with after-tax money, meaning the individual pays taxes on the amount upfront. Any contributions made for the year must be included in their taxable income for that year. On the plus side, qualified contributions are tax-free upon withdrawal.
Individuals whose adjusted gross income exceeds the IRS’ threshold cannot contribute to a Roth IRA.
Which states have retirement mandates?
Over 30 states have considered legislation for state-sponsored retirement plans, says the National Association of Insurance and Financial Advisors. States that have introduced legislation include Arizona, Colorado, Indiana, Kentucky, Louisiana, Maine, Ohio, North Dakota, Nebraska, New Hampshire, Utah, North Carolina, Wisconsin, Virginia, and West Virginia.
To date, the following 10 states have enacted legislation establishing a state-sponsored retirement program:
- New Jersey
- New York
What are the requirements for employers and employees?
The rules for state-mandated retirement plans — including how they impact employers and employees — vary from state to state. Let’s take California, Illinois, and Massachusetts, for example.
Employers in California with at least 5 employees must offer a retirement savings plan either through the private market or the state’s CalSavers program. Since CalSavers is a Roth IRA, the IRS’ contribution guidelines apply.
Deadline for employers to enroll in CalSavers:
To be eligible for CalSavers, employees must be at least 18 years of age. They must also receive a Form W-2 with California wages. Additionally:
- The default savings amount is 5% of gross wages; employees can designate a different amount
- Contributions must be made via payroll deduction
- Employer contributions are not allowed
- Employees must be allowed to opt-out of the program
CalSavers is free for employers to use. According to Guideline.com, CalSavers “will be paid for by employee participant fees which are expected to shrink as the program scales up.”
Employers in Illinois must offer the state’s retirement savings plan — known as Illinois Secure Choice — if:
- They have at least 25 employees
- They have been in business for at least 2 years
- They do not offer a qualified retirement savings plan, such as 401(k) or Simple IRA
- The default savings rate is 5% of gross wages
- Contributions are made via payroll deduction
- Employers cannot make contributions
- Employers do not have to choose the state plan; they can offer a different, qualified retirement plan
- Employers that choose Secure Choice must automatically enroll their employees in the program
- Employees must be allowed to opt-out of the program or to increase or decrease their payroll deduction amount (from the default 5%)
Since the Illinois Secure Choice is a Roth IRA, employees must meet the IRS’ income limits to be able to contribute.
The deadlines for existing employers to enroll in Secure Choice have passed, with the last cutoff being November 2019 for businesses with 25-99 employees.
Massachusetts limits its state-run retirement savings initiative to nonprofit organizations with 20 or fewer employees. Specifically, the Massachusetts Defined Contribution CORE Plan permits nonprofits with 20 or fewer employees to offer retirement benefits through a 401(k) multiple employer plan (MEP). This varies from most other state-run retirement plans, which facilitate the benefit only through a Roth IRA.
Additionally, the CORE Plan:
- Offers both pretax and Roth 401(k) options
- Employers can choose to make “safe harbor” matching contributions
- Employee contributions are made through payroll deduction
- The program is voluntary for employers and employees
- The default savings amount is 6% of gross wages, on a pretax basis
- Employees must be permitted to opt out of the plan or to change their contribution amount
Are there penalties for noncompliance?
As stated in an eBook by PAI Retirement Services, “If mandated by the state, employers must enroll their workers into the state-run program through the payroll process.”
Failure to abide by state mandates may result in penalties, which are imposed at the state level.
For example, the penalty for not allowing eligible employees to participate in CalSavers range from $250-$500 per eligible employee.
What are the pros and cons of a state-mandated retirement plan?
Next steps for small employers
If your state sponsors a retirement plan for private-sector workers, take a close look at the specifics. See how the pros and cons stack up against your business objectives and your employees’ needs. If you’re allowed to obtain your retirement plan through the private market, determine whether you should go that route or with the state plan. Consider seeking expert advice to guide you through your decision making.